I Sold My I-Bonds And Consider Waiting To Buy More

Time To Get Real

I started covering Series I US Savings Bonds on this site in April 2021, when it became clear from the CPI numbers that an inflation spike had started, and bonds sold after 5/1/2021 would earn 3.53% APR for the first six months. At the time, I-Bonds were a no-brainer decision compared to the near zero rates being offered on CDs and T-Bills. This was true even with the fixed component of the I-Bond rate set at zero.

Recall that I-Bond rates are announced by the US Treasury every May 1 and November 1. The fixed component is set when you buy the bond and remains constant over its life. The variable component changes 6 months after you buy the bond and every 6 months thereafter, based on the change in CPI over the prior April-September or October-March period.

For a couple of years, I-Bonds remained superior to money markets, CDs and T-Bills as it took time for short term interest rates to catch up to inflation. During that time, I was recommending purchasing the maximum allowable amount of $10,000 per year per individual electronically, plus up to $5,000 in paper bonds in lieu of an income tax refund.

Eventually, real (inflation-adjusted) interest rates turned positive in June 2022, just as year-on-year CPI growth was peaking. This was followed by the first nonzero fixed rate on I-Bonds in 2.5 years (0.4%) starting in November 2022. By the spring of 2023, money markets, CDs and T-Bills offered better returns than I-Bonds, even though the fixed rate increasing to 0.9% in May was higher than I expected.

Real interest rates are now around 2.4%, as measured by the yields on Treasury Inflation Protected Securities or TIPS. The differences between TIPS and I-Bonds are well-covered on Treasury Direct as well as by other authors on this site. I consider TIPS to be more of a long-term, held to maturity type investment while I-Bonds can be a cash alternative that does not lose value when market interest rates go up. Nevertheless, the real rates available in TIPS are effectively embedded in other cash investments even if not an explicit part of the formula as with I-Bonds. That helps make other cash alternatives better than I-Bonds, especially ones bought during the zero fixed rate period. Here are some examples currently available:

Brokered CD's may offer even higher rates, but many are callable, which presents reinvestment risk if rates drop.

Following the latest CPI release, we now know the next 6-month rate for I-Bonds will be 3.94%. While this is an improvement over the prior 6-month period rate of 3.39%, I-Bonds purchased during the zero fixed rate regime will earn an uncompetitive rate for the next 12 months:

(1+.0339/2)*(1+.0394/2)-1 = 3.70%

For this reason, I have sold my I-Bonds bought during the zero fixed rate period. For investors considering new purchases of I-Bonds, the current 0.9% fixed rate makes them a bit more attractive, however I expect the fixed rate to increase even further on November 1. Even so, with I-Bond rates only changing every 6 months, those who want to buy one could still do better by buying a 6-month T-Bill now and rolling it into an I-Bond in April 2024.

Rates On New I-Bond Purchases

With the latest CPI release, we now know exactly what an I-Bond purchased between now and October 31 will yield over the next 12 months of interest payments: 4.64%.

This yield could be competitive with money markets and CDs if you are in a high tax bracket in a high-tax state. However, T-Bills enjoy the same state tax exemption with a higher yield.

Given the increase in real yields in the past 6 months, the I-Bond fixed rate component will almost certainly increase on November 1. My model based on the last 20 years of history and current real rates predicts a fixed rate of 1.3% at the next reset, but because it underpredicted last time, I will use a fixed rate of 1.5% as my forecast, identical to Jim Sloan's guess in his recent I-Bond article.

The yield for the first year on I-Bonds bought after 11/1 is still a forecast, not a certainty. We do know the 3.94% variable component for the first 6 months. I am assuming the 1.5% fixed component as discussed above. For the second 6-month variable component, I am guessing CPI will increase 0.25% per month, or 3% per year. Given these assumptions, an I-Bond purchased after 11/1 will earn 5.07% in the first year. This rate will be competitive against money markets and CDs in most states that collect a state income tax.

A 6-month T-Bill still beats my forecasted I-Bond yield. Since the starting rate on I-Bonds will be the same from 11/1/2023 to 4/30/2024, investors can maximize their options by buying a 6-month T-Bill in October. In April 2024, the variable I-Bond rate for the second 6 months will be known, and we will also have a good idea if the fixed rate will improve or go down on 5/1/24.

The only drawback of the T-Bill is that you will owe federal income tax on the gain in 2024 (if not in a tax advantaged account). The I-Bond interest can be deferred until you sell. The downside of I-Bonds is the loss of the last three months of interest if redeemed within 5 years of purchase. While you can redeem an I-Bond after 12 months, all the "1 year" I-Bond yields discussed above require holding until the 1st day of the 15th month after purchase to receive the stated total return.

Conclusion

At the start of the recent inflation spike, I-Bonds were clearly the highest-returning safe investment that guarantees a return of at least original capital. Since then, inflation seems to have peaked, and the Fed has gotten more serious about keeping it under control. This has allowed market interest rates on money markets, CDs, and T-Bills to be superior to I-Bond rates, especially those bought when the fixed rate was zero. Nevertheless, the fixed rate component on I-Bonds has been increasing and is due for another hike on November 1. While it's possible I-Bonds may rise to the top of the pecking order when the new fixed rate is out, my forecast of 1.5% leaves I-Bonds still below T-Bills in yield. Since I-Bond rates only reset every 6 months, buying a 6-month T-Bill now and deferring the I-Bond purchase decision to April 2024 seems like a good strategy.